Arindam Guha,

The author is Partner, Deloitte India and is based out of Kolkata

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Cities are becoming smart but what about financing?

When it comes to source of financing, most of the smart city plans envisage around 70 per cent of the total outlay to be funded by the Central and State Government, either through the Smart City Mission or through convergence schemes like AMRUT, Swachh Bharat etc.

As the Government’s Smart City Mission completes 3 years, a number of cities have been in the news for implementing innovative technology led projects like City Command and control Center, Smart Parking, City Surveillance, Intelligent traffic management etc. However, as more cities move into implementation, it becomes important to look at sustainability of the solutions which are getting implemented.

From the viewpoint of sustainability, the first issue which comes to mind is financing. Most of the current projects are being implemented by multi-system integrators (MSI) or Engineering, Procurement & Construction (EPC) companies (for urban infrastructure projects) on turnkey basis, including operations and maintenance (O&M) support over a period of 5 years. Thus, in addition to one time investments, O&M charges are payable to the MSI or EPC operator which typically account for 50-60 per cent of the initial investments.

When it comes to source of financing, most of the smart city plans envisage around 70 per cent of the total outlay to be funded by the Central and State Government, either through the Smart City Mission or through convergence schemes like AMRUT, Swachh Bharat etc. The challenge lies in the balance 30 per cent which is supposed to be funded by the private sector either through public private partnership (PPP) projects or through issue of municipal bonds / similar instruments.

In most cities, there would be a need for a significant scale up in both number and size of PPP projects, for them to mobilize target private investments. There are a number of underlying factors which may need to be addressed for this to happen. In India, large scale PPPs have by and large been limited to projects involving construction of urban commercial infrastructure with the Government contribution primarily being in the form of land. With most of the identified smart cities falling under the brownfield development category and Government land holding being fragmented across multiple Departments / agencies in most cities, it has not been possible to leverage this asset base beyond a point, other than a few Smart cities undergoing green field development. Consequently, the number of such projects has been limited.

This has been one of the major differences viz. a viz. China for example, where all urban land is owned by the local / city Government. Consequently, land monetization was one of the main sources of financing for Chinese cities during the Special Economic Zone (SEZ) development phase of the eighties. Most local / city Governments in SEZs like Shenzhen, Zhuhai and Xiamen mortgaged the land against borrowings from state owned banks, with the borrowings being used to develop urban and other connecting infrastructure like roads, railways, airports etc. for the SEZ. Land parcels in the SEZ was then leased to both domestic and foreign private investors at market rates by the city / local Government, with the proceeds being used to service bank borrowings. For this model to be replicated in India, (a) consolidation of all Government land holdings under the Smart City SPV and (b) strengthening the linkage between identified Smart Cities and economic and industrial development initiatives like Coastal Economic Zones, Industrial Corridors etc. would be required.

When we look at other types of PPP projects, there have been some initiatives like setting up smart poles etc. where the Government has provided right of way to the private partner making investments in smart infrastructure, which is then used by Government at concessional prices. However, the contribution of such projects in value terms continues to be limited.

The other category of smart city projects involving significant outlays is in areas like water supply and solid waste processing. Here again, while there have been some success stories, private sector response continues to be muted in most cities primarily due to the inability to levy user charges reflecting the cost of service delivery. The solution possibly lies in the adoption of an independent regulatory mechanism which enables (a) accurate assessment and monitoring of cost of service delivery leveraging smart technology and (b) using a cross subsidy model for levy of differential user charges across different user groups / segments to enable recovery of cost of service delivery at an overall level.

In addition to PPP projects, the other envisaged route for mobilizing private investments was issue of municipal bonds and similar instruments. To this end, many of the Smart cities had gone in for credit rating exercises as a precursor to bond issuance. However, only around half of them have secured investment grade rating and out of these, a limited few like Pune, Hyderabad have actually gone ahead with issuing bonds. Many cities have had to be content with sub investment grade ratings primarily due to financial sustainability related issues, with user charges for key municipal services like water supply, solid waste management etc. being inadequate to cover cost of service delivery.

For the technology driven citizen facing initiatives under the Smart City Mission to be financially sustainable, it is therefore important to create the right policy, regulatory and institutional framework for (a) aggregation and monetization of Government land holding and (b) rationalization of municipal user charges based on cost of service delivery. Such measures are likely to enable the mission to leave a lasting impact on the urban development landscape of the country.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house